Download In Re: Gravity Co., Ltd. Securities Litigation 05-CV

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
IN RE GRAVITY CO ., LTD . SECURITIES
LITIGATION
x
: Civil Action No . 1 :05-CV-04804-LA P
(Consolidated)
CLASS ACTIO N
CONSOLIDATED CLASS ACTION
COMPLAINT FOR VIOLATIONS OF
FEDERAL SECURITIES LAWS
This Document Relates to :
ALL ACTIONS .
x
Lead Plaintiff Pipefitters, Locals 522 and 633 Pension Trust Fund ("Lead Plaintiff'), o n
behalf of itself and all others similarly situated, asserts the following allegations, except as t o
allegations specifically pertaining to Lead Plaintiff and Lead Plaintiffs counsel, based upon the
investigation undertaken by its counsel, which included analysis of publicly available news article s
and reports, public filings, securities analysts' reports and advisories about Gravity Co ., Ltd.
("Gravity" or the "Company"), press releases and other public statements issued by the Compan y
and media reports about the Company, and believe that substantial additional evidentiary suppor t
will exist for the allegations set forth herein after a reasonable opportunity for discovery .
NATURE OF THE ACTION
1 . This is a federal securities class action on behalf of a class consisting of all persons ,
other than Defendants, who purchased the American Depository Shares ("ADSs") of Gravity (th e
"Class") from February 7, 2005 (the "IPO") through November 10, 2005 (the "Class Period") ,
seeking to pursue remedies under the Secu rities Act of 1933 (the "Securities Act") and the Securitie s
Exchange Act of 1934 (the "Exchange Act" )
JURISDICTION AND VENUE
2. The claims asserted herein arise under and pursuant to Sections 11,12(a)(2) and 15 o f
the Securities Act [15 U .S.C. §§77k, 77l(a)(2) and 77o ] and §§l0 (b) and 20(a) of the Exchange Act
[15 U .S.C. §§78j(b) and 78t(a )] and Rule lOb-5 promulgated thereunder [17 C .F.R. §240.10b-5] .
This Court has jurisdiction over this action pursuant to §27 of the Exchange Act [15 U .S.C. §78aa ]
and 28 U .S .C . §§1331 and 1337 .
3. Venue is properly laid in this District pursuant to Section 22 of the Securities Act ,
Section 27 of the Exchange Act and 28 U .S.C. § 1391(b) and (c) . The actions and conduc t
complained of herein occurred in substantial part in this District . Gravity ADSs are traded over th e
NASDAQ national market which is based in this District .
-1-
4. In connection with the acts and conduct alleged in this Complaint, Defendants ,
directly or indirectly, used the means and instrumentalities of interstate commerce, including th e
mails and telephonic communications and the facilities of the NASDAQ Stock Market (th e
"NASDAQ"), a national securities exchange.
PARTIE S
5 . Lead Plaintiff purchased Gravity ADSs pursuant and/or traceable to the IPO, a s
defined herein, and as set forth in the certification previously submitted in this litigation, which is
incorporated by reference herein, and was damaged thereby .
6. Defendant Gravity is a Korean corporation with its p rincipal place of business i n
Seoul, Korea . Gravity is a developer and distributor of online games . The of Gravity ADSs publicl y
trade on the NASDAQ under the ticker symbol "GRVY ."1
7. (a) Defendant Richard HyonKook Kim ("R. Kim") became Gravity's Chie f
Executive Officer ("CEO") and a Director in August 2004 . Shortly after the IPO, in March 2005 ,
Gravity's Board "replaced" R . Kim as CEO, assigning him the title of Chief Strategy Office r
("CSO") responsible for the Company's global operations . Five months later , in August 2005, R .
Kim resigned from his positions as Gravity's CSO and Director . R. Kim signed the Company' s
Registration Statement or it was signed for him by an Attorney-in-Fact . R . Kim sold 1 .830 million
ADSs in the IPO generating total proceeds before expenses of approximately $23 million .
(b) Defendant Kwan Shik Seo ("Seo") became Gravity's Chief Financial Office r
("CFO") and a Director in August 2004 . In his capacity as CFO, Seo was entrusted wit h
responsibilities for overall investor relations, financial reporting, and improving and enhancing th e
1 One fourth of one common share underlies each ADS .
-2-
Company's internal control over financial reporting in compliance with Section 404 of the SarbanesOxley Act ("SOX") . Shortly after the IPO, in July 2005, Gravity's Board appointed a new CFO and
assigned Seo the responsibility of improving Gravity's internal control over its financial reporting in
his capacity as the Company's Corporate Controller . On November 7, 2005, Seo resigned from his
position as Corporate Controller for "personal reasons" and on January 8, 2006, resigned from the
Company' Board. Seo signed the Company's Registration Statement or it was signed for him by a n
Attorney-in-Fact.
(c) Defendant David Woong-Jin Yoon ("Yoon") became a Gravity Boar d
member in December 2004 and signed the Company' s Registration Statement or it was signed fo r
him by an Attorney-in-Fact. Yoon acted as Gravity's CEO from March 2005 through September 21 ,
2005, when he became Gravity's President . On November 11, 2005, the Board suspended Yoo n
from his position as the Company's President and, on December 6, 2005, Yoon resigned as a
member of the Company's Board. During the Class Period, Gravity referred to Yoon as a "financia l
expert."
(d) Defendant Jung Ryool Kim ("J . Kim") is one of Gravity's founders and wa s
the Company's Board Chairman . J. Kim became a Gravity Director in 2000 and signed th e
Company's Registration Statement or it was signed for him by an Attorney-in- Fact. In August 2005 ,
Gravity reported that J . Kim and his children sold their entire interest in the Company, or 52 .4% o f
Gravity's common shares, to EZER Inc . ("EZER"), a Japanese company . On September 21, 2005 J .
Kim resigned as a Board member .
(e) Defendant Yeon Ho Moon ("Moon") has served as Gravity's Chief Operatin g
Officer ("COO") and a Director since November 2002 . Moon signed the Company's Registration
Statement or it was signed for him by an Attorney-in-Fact . Although Moon was not a named
-3-
Gravity Officer or Director as of September 21, 2005, the Company has never reported when h e
resigned from such positions .
(f) Defendant Sung Hee Lee ("S . Lee") was a Director of the Company and
signed the Company' s Registration Statement or it was signed for him by an Attorney-in-Fact .
Although S . Lee was not a named Gravity Director as of September 21, 2005, the Company never
reported when he resigned from such position .
(g) Defendant Eun Jong Lee ("E . Lee") was a Director of the Company and
signed the Company's Registration Statement or it was signed for him by an Attorney-in-Fact.
Although E . Lee was not a named Gravity Director as of September 21, 2005, the Company neve r
reported when he resigned from such position .
(h) Defendant Myung Whan Suh ("Suh") was a Director of the Company unti l
September 21, 2005, and signed the Company's Registration Statement or it was signed for him b y
an Attorney-in-Fact .
8 . The Defendants referenced above in ¶7 are collectively referred to herein as the
"Individual Defendants ." The Defendants referenced above in ¶'j6 and 7 are collectively referred t o
herein as the "Defendants ."
9. (a) Defendant Credit Suisse First Boston ("Credit Suisse") is an investment ban k
which acted as one of the underwriters for the IPO . Credit Suisse maintains executive offices in thi s
District.
(b) Defendant Daewoo Secu rities Co ., Ltd . ("Daewoo ") is an investment bank
which acted as one of the underwriters for the IPO . Daewoo maintains executive offices in thi s
District.
-4-
(c) Defendant CIBC World Markets Corp . ("CIBC") is an investment bank which
acted as one of the underwriters for the IPO . CIBC maintains executive offices in this District .
(d) CLSA Limited ("CLSA") is an investment bank which acted as one of the
underwriters for the IPO .
10 . The Defendants referenced above in ¶9 are collectively referred to herein as th e
"Underwriter Defendants."
PLAINTIFF'S CLASS ACTION ALLEGATION S
11 . Plaintiff brings this action as a class action pursuant to Federal Rules of Civi l
Procedure 23(a) and 23(b)(3) on behalf of itself and all persons who purchased the ADSs of Gravit y
during the Class Period (the "Class") and who were damaged thereby .
12 . Excluded from the Class are Defendants herein, members of the immediate family o f
each of the Defendants, any person, firm, trust, corporation, officer, director or other individual o r
entity in which any Defendant has a controlling interest or which is related to or affiliated with an y
of the Defendants, and the legal representatives, agents, affiliates, heirs, successors-in-interest or
assigns of any such excluded party.
13. The members of the Class are so numerous that joinder of all members i s
impracticable . Approximately eight million Gravity ADSs were sold in the IPO . The precise
number of Class members is unknown to Plaintiff at this time but is believed to be in the thousands .
In addition, the names and addresses of the Class members can be ascertained from the books an d
records of Gravity or its transfer agent, Market Makers or Underwriters . Notice can be provided to
such record owners by a combination of published notices and first-class mail, using techniques and
a form of notice similar to those customarily used in class actions arising under the federal securitie s
laws .
-5-
14 . Lead Plaintiff will fairly and adequately represent and protect the interests of th e
members of the Class . Lead Plaintiff has retained competent counsel experienced in class action
litigation under the federal securities laws to further ensure such protection and intends to prosecut e
this action vigorously.
15. Lead Plaintiffs claims are typical of the claims of the other members of the Class
because Lead Plaintiff's and all the Class members' damages arise from and were caused by th e
same representations and omissions made by Defendants . Lead Plaintiff does not have any interests
antagonistic to, or in conflict with, the Class .
16. A class action is superior to other available methods for the fair and efficien t
adjudication of this controversy. Since the damages suffered by individual Class members may be
relatively small, the expense and burden of individual litigation make it virtually impossible for th e
Class members to seek redress for the wrongful conduct alleged . Plaintiff knows of no difficulty tha t
will be encountered in the management of this litigation that would preclude its maintenance as a
class action.
17 . Common questions of law and fact exist as to all members of the Class an d
predominate over any questions affecting individual members of the Class . Among the questions o f
law and fact common to the Class are :
(a) whether the federal securities laws were violated by Defendants' acts a s
alleged herein ;
(b) whether the Prospectus and Registration Statement (defined below) issued b y
Defendants to the investing public in connection with the IPO omitted and/or misrepresente d
material facts about Gravity and its business ;
-6-
(c) whether Defendants' statements issued during the Class Period wer e
materially false and misleading ; and
(d) the extent of injuries sustained by members of the Class and the appropriat e
measure of damages .
SUBSTANTIVE ALLEGATION S
The Company and Its Busines s
18 . Defendant Gravity is a developer and distributor of online games . The Company was
incorporated in the Republic of Korea on April 4, 2000, and on March 14, 2003, the Company
established Gravity Interactive , LLC ("Interactive"), its wholly- owned subsidiary based in the
United States .2
19. Gravity describes its operations as consisting of four product lines : ( 1) massive ,
multiplayer, 'online role-playing games ; (2) mobile games ; (3) animation; and (4) character-base d
merchandise . Substantially all of its revenues, however, have been derived from a single product ,
Ragnarok Online, which the Company launched in August 2002 and is commercially offered for sal e
in more than 35 countries worldwide .
20 . Ragnarok Online is an online video game which can be played by thousands o f
players at the same time (commonly referred to as a massive multiplayer game) . Pre-IPO, Ragnaro k
Online accounted for more than 95% of the Company's revenue and more than 80% of th e
Company's sales were made to customers in Korea, Japan and Taiwan .
2 The California Secretary of State's office lists Interactive' s business address as 4505 Glencoe
Avenue, 2nd Floor, Marina Del Rey, CA, 90292 .
-7-
The IPO
21 . On January 20, 2005, Gravity filed a registration statement on Form F-I for the sale
of 9 .3 million ADSs - 6,510,000 ADSs which were to be offered by the Company and 2,790,000
ADSs which were to be offered by selling shareholders - with the SEC .
22 . On January 31, 2005, Gravity filed a Form F-l/A registration statement (th e
"Registration Statement ") with the SEC .
23 . On February 7, 2005, the prospectus (the "Prospectus"), which forms part of th e
Registration Statement , was declared effective by the SEC and Gravity and the selling shareholders
sold at least 8 million ADSs for $13 .50 per ADS . The Prospectus indicated that the offering ha d
been reduced to 5 .6 million ADSs to be sold by the Company and 2 .4 million ADSs to be sold b y
selling shareholders .3 Defendant R . Kim sold common shares equivalent to approximately 1 .83
million ADS in the IPO, or approximately 76% of the ADSs sold by the selling shareholders .'
24 . The Prospectus stated that Gravity intended to use the majority of the IPO proceeds to
finance game development with the balance of the proceeds slated for working capital needs an d
enhancements to its technological, marketing, distribution and servicing capabilities .
Defendant J . Kim Engages In A Systematic
Scheme To Divert Raganrok Online Royalty Payment s
25 . Prior to the IPO, Defendant J . Kim engaged in a scheme to embezzle royalty revenue s
from Gravity's sales of Ragnarok Online . Defendant J . Kim opened bank accounts in the name o f
the Company (or in the name of other companies under his control) and directed certain licensees t o
3 The information concerning the IPO of the Company's ADSs herein excludes any underwriter
over-allotment option to purchase additional ADS .
' As noted above, each ADS represents one fourth of one common share . Accordingly, the 8 .0
million total ADSs sold in the IPO represented 2 .0 million newly issued Gravity common shares .
-8-
send Ragnarok Online royalty payments to the accounts . In total, Defendant J . Kim embezzled at
least $6 million from the Company through this scheme (the "Embezzlement Scheme") .
26. At the time of the Embezzlement Scheme, Defendant J . Kim did not serve in a
managerial role at Gravity and only maintained his position as a Director of the Company an d
Chairman of the Board of Directors. Defendant J. Kim was able to engage in the Embezzlement
Scheme because Gravity lacked sufficient internal controls over its financial reporting . In particular,
Gravity had a :
• In effective control environment thereby enabling the Company's former Chairman
to take numerous inappropriate actions resulting in the Restatement ;
• Lack of independent oversight and supervision controls ;
• Lack of controls over the reported revenues from Gravity' s oversea licensees ;
• Lack of control over back accounts;
• Lack of sufficient complement of personnel ;
• Lack of controls over the purchase and accounting for fixed assets ; and
• Lack of controls over the financial close and reporting process .
27 . Ultimately, the Embezzlement Scheme came to light and was investigated by th e
Company . As detailed herein, in connection with that investigation, Gravity discovered numerous
other improper and intentional accounting issues which existed at the time of the IPO .
The Registration Statement and Prospectus Contained Numerous Untrue Statements Of
Material Fact And Omitted To State Material Facts Required To Be Stated Therei n
28. The Registration Statement and Prospectus contained numerous untrue statements o f
material facts and omitted to state material facts required to be stated therein . Specifically, the
Prospectus contained financial statements that did not comply with GAAP, failed to disclose the true
risks associated with investing in Gravity ADSs and made untrue statements of material fact abou t
the Company's core product .
-9-
The Prospectus Contained Financial
Statements Which Were Materially Inaccurate
and Violated U.S. GAA P
29. The Prospectus contained Gravity's audited consolidated balance sheets as o f
December 31, 2002 and 2003 and its audited consolidated statements of operations, changes in
shareholders' equity and cash flows for the years ended December 31, 2001, 2002 and 2003 . In
addition, the Prospectus included Gravity's unaudited consolidated balance sheets as of September
30, 2003 and 2004 and its unaudited consolidated statements of operations, changes in shareholders '
equity and cash flows for the nine months ended September 30, 2003 and 2004 . The Prospectu s
represented that the financial statements contained therein, as enumerated above, as well as th e
financial information based upon such financial statements, were prepared in conformity with U .S .
GAAP . The Prospectus stated in pe rtinent part as follows:5
Basis of presentatio n
The accompanying consolidated fin ancial statements have been prepared in
accordance with accounting p rinciples generally accepted in the United States of
America ("US GAAP") .
30 . The financial statements included in the Prospectus were each materially inaccurate i n
the following respects as they negligently misrepresented and/or omitted the following existing facts ,
the disclosure of which was necessary to make the statements made not false and/or misleading :
(a) Gravity prematurely recorded revenues prior to the shipment of products t o
customers and the customers' assumption of risk of ownership for the products . Specifically ,
5 Regulation S-X [ 17 C .F. S §210.4 -01 (a)(1)] states that financial statements filed with the SEC that
are not prepared in conformity with GAAP are presumed to be misleading and inaccurate . GAAP
are those principles recognized by the accounting profession as the conventions, rules and
procedures necessa ry to define accepted accounting practices at a pa rticular time . Generally
Accepted Auditing Standard ("GAAS") §AU 411 .02 .
-10-
Gravity improperly recognized certain revenue in connection with the Company's mobile game s
revenue and character merchandising, animation and other revenue relating to products in the year
ended December 31, 2004 ;
(b) Gravity improperly failed to recognize revenue that Defendant J . Kim
"dive rted." Defendant J . Kim was able to misappropriate Gravity' s royalty revenues even though ,
according to the Company's public disclosures, he never held a management position with Gravity ;
(c) Gravity's revenues for fiscal years 2000 through 2004 were misstated b y
millions of dollars ;
(d) Gravity reported certain fixed assets that it neither possessed nor controlled .
Gravity has now stated that such "assets" cannot be identified and, as a result, has charged the valu e
of such phantom assets against its earnings ;
(e) Gravity incorrectly reported foreign tax credits and income tax provisions i n
"prior periods" and misstated its income taxes payable ; an d
(f) Gravity incorrectly reported foreign currency gains and losses, account s
receivable, deferred income tax assets, other current assets, deferred income, operating cash flows ,
cash flows from investing activities and shareholders' equity .
31. Based on the foregoing, the financial statements contained in the Prospectus violate d
GAAP in the following respects :
(a) The principle that revenue can not be recognized until the customer has taken
title to, and assumed the risks and rewards of ownership of the products specified in the customer' s
purchase order or sales agreement . (SEC Staff Accounting Bulletin ("SAB") Nos . 101 and 104;
FASB Concept Statement Nos . 2 and 5; Statement of Financial Accounting Standard ("SFAS") No .
48 ; Accounting Research Bulletin No . 43; Accounting Principles Board ("APB") Opinion No . 10;
-11-
and American Institute of Certified Public Accountants' Statement of Position 97-2) . The principle
that financial statements appropriately account for and report income tax credits . (SFAS No. 109) ;
(b) The concept that an asset is a "probable future economic benefit" obtained or
controlled by a particular entity as a result of past transactions or events . (Concepts Statement No .
6);
(c) The concept that an essential characteristic of an asset is that an entity ca n
control its future economic benefit and deny or regulate others access to the benefit . (Concepts
Statement No . 6) ;
(d) The concept of completeness , which means that nothing is left out of th e
information that may be necessary to ensure that it validly represents underlying events an d
conditions . (Concepts Statement No . 2, ¶79) ;
(e) The concept that conservatism be used as a prudent reaction to uncertainty s o
that risks and uncertainties inherent in business situations are adequately considered . The best way
to avoid injury to investors is to try to ensure that what is reported represents what it purports t o
represent. (Concepts Statement No . 2, ¶'195-97) ;
(f) The concept that financial reporting provide information that is useful to
present and potential investors and creditors and other users in making rational investment, credi t
and similar decisions . (Concepts Statement No . 1,'34) ;
(g) The concept that financial reporting should provide information about th e
economic resources of an enterprise, the claims to those resources, and the effects of transactions ,
events and circumstances that change resources and claims to those resources . (Concepts Statement
No . 1, ¶40) ;
-12-
(h) The concept that financial reporting should provide information about ho w
management of an enterprise has discharged its stewardship responsibility to owners (stockholders )
for the use of enterprise resources entrusted to it . To the extent that management offers securities o f
the enterprise to the public, it voluntarily accepts wider responsibilities for accountability t o
prospective investors and to the public in general . (Concepts Statement No . 1, ¶50) ; and
(i) The concept that investors and creditors often use an entity's historica l
financial information in assessing the future prospects of the enterprise . Thus, although investment
and credit decisions reflect investors' expectations about future enterprise performance, those
expectations are commonly based, at least partly, on evaluations of past enterprise performanc e
( Concepts Statement No. 1, ¶42).
32 . Accordingly, the financial statements in the Prospectus were not prepared i n
accordance with GAAP and the statement referenced above in ¶ 29 that the financial statements wer e
prepared in accordance with "accounting principles generally accepted in the United States o f
America ("US GAAP")" was an untrue statement of mate rial fact. In addition, pursuant to SE C
regulations , Item 4 of Form F - l, the Prospectus was required to include financial statements which
complied with Regulation S-X.6 Regulation S-X [17 C.F.S §210 .4-01(a)(1)] states that financial
statements filed with the SEC that are not prepared in conformity with GAAP do not comply with
Regulation S-X and are presumed to be misleading and inaccurate .
By including financial
statements that were not prepared in accordance with GAAP, the Prospectus omitted to state mate ri al
facts required to be stated therein .
6 Forms 20-F and 10-K are respectively used by Foreign and Domestic issuers to file their annual
reports with the SEC .
-13-
33. Furthermore, the footnotes to the financial statements contained in the Prospectu s
which referenced the Company's "significant accounting policies" were untrue statements o f
material fact .? U. S. GAAP, in APB Opinion No. 22, provides that information about the accountin g
policies adopted by a company is "essential " for financial statement users . The Prospectus listed the
following accounting policies, among others :
Revenue recognitio n
Online games - subscription revenu e
Prepaid online game subscriptions are deferred and recognized based upon
their actual usage .
Online games - royalties and license fees
The Company licenses the right to sell and distribute its games in exchange
for an initial prepaid license fee and guaranteed minimum royalty payments . The
prepaid license fee revenues are deferred and recognized ratably over the license
period. The guaranteed minimum royalty payments, which are currently only paid in
China, are deferred and recognized as the royalties are earned . In addition, the
Company receives a royalty payment based on a specified percentage of the
licensees' sales. These royalties, that exceed the guaranteed minimum royalty, are
recognized on a monthly basis, as the related revenues are earned by the licensees .
In February and April, 2002, the Company entered into agreements with Sunny
YNK, Inc. ("Sunny YNK") pursuant to which the Company granted it the exclusive
right to distribute RAGNAROK for a contractual period of three years from the date
RAGNAROK was first commercialized. The relationship with Sunny YNK is such
that the Company acts as the primary obligor with the end-user, and in the majority
of situations the end-user is not aware of the existence of Sunny YNK . The game is
marketed and branded by the Company, and it takes full responsibility for any
customer complaints, questions and support and is responsible for fixing any bugs
that are identified. The Company develops content and maintains legal ownership of
the copyrights or licenses to the games . It hosts the delivery of the games on its
servers and can refuse end-users from participating in game play . The Company has
the right to stop providing services to support the game at any time . In accordance
with Emerging Issues Task Force ("EITF") No . 99-19, Reporting Revenue Gros s
' Such accounting polices were also inaccurately set forth in the "Critical Accounting Policies"
section of the Prospectus .
-14-
versus Net, the Company presents the entire revenue derived from the Sunny YNK
license arrangement in its statement of operations .
Property and equipmen t
Property and equipment are stated at cost, less accumulated depreciation .
Depreciation for equipment, furniture and fixtures, vehicles, capital lease assets and
purchased software is computed using the straight-line method over the following
estimated useful lives :
Computer and equipment
Furniture and fixtures
Software
Vehicles
Capital lease assets
4 years
4 years
3 years
4 year s
4 year s
Leasehold improvements are amortized on a straight-line basis over the
estimated useful life of the assets or the lease term, whichever is shorter .
Significant renewals and additions are capitalized at cost . Maintenance and
repairs are charged to income as incurred .
Income taxes
The Company accounts for income taxes under the provisions of SFAS No .
109, Accounting for Income Taxes . Under SFAS No . 109, income taxes are
accounted for under the asset and liability method . Deferred taxes are determined
based upon differences between the financial reporting and tax bases of assets and
liabilities at currently enacted statutory tax rates for the years in which the
differences are expected to reverse .
A valuation allowance is provided on deferred tax assets to the extent that it is
more likely than not that such deferred tax assets will not be realized . The total
income tax provision includes current tax expenses under Gravityble tax regulations
and the change in the balance of deferred tax assets and liabilities .
These statements were untrue because Gravity did not follow its stated accounting policies .
34. Gravity has admitted that the financial statements contained in the Prospectus wer e
materially untrue when issued and that at the time of the IPO (and thereafter) it did not follow it s
publicly stated accounting policies .
-15-
35 . On November 10, 2005, Gravity issued a press release announcing that it would b e
restating its historical financial statements as of, and for each of, the years ended December 31 ,
2002, 2003 and 2004 as well as the quarterly financial statements for each of the three months ende d
March 31, 2005, and June 30, 2005 (the "Restatement") . Gravity announced that such financial
statements "should not be relied upon ". The press release stated in pertinent part as follows :
The audit committee of the board of the directors of the Company (the "Audit
Committee") has determined that the Company's audited consolidated financial
statements as of and for each of the years ended December 31, 2002, 2003 and
2004 and its unaudited quarterly financial statements as of and for each of the three
months ended March 31, 2005 and June 30, 2005 (the "Financial Statements") will
need to be restated. The need for a restatement of the Financial Statements arises
from the discovery and current investigation by the Audit Committee into the fact
that certain royalty payments payable to the Company from certain licensees were
not properly accounted for in the Financial Statements (the "Investigation") . The
Investigation was previously disclosed in the Company's report on Form 6-K
furnished to the Securities and Exchange Commission on October 18, 2005 . As a
result of the foregoing, our Financial Statements should not be relied upon until
the investigation is completed and investors should look to the Financial Statements
in their restated form when they become available . Also, the Company and the Audit
Committee have determined that financial statements as of and for the three months
ended September 30, 2005 will be released only after completion of the Investigation
and the restatement by the Company of its Financial Statements . [Emphasis added .]
36 . On May 12, 2006, Gravity filed an amended 2004 annual report on Form . 20-F/A with
the SEC (the "Amended 2004 20-F"). The Amended 2004 20-F detailed the Company' s
investigation into the diversion of revenues by Defendant J . Kim and stated that the "impact of th e
diversion was such that revenues were improperly omitted from the Original Financial Statements . "
The Amended 2004 20-F stated in pertinent part as follows :
In November 2005, the audit committee of the board of the directors of the
Company (the "Audit Committee") determined that the Company 's audited
consolidatedfinancial statements as of December 31, 2003 and 2004 and for each
of the years ended December 31, 2002, 2003 and 2004 (the "Original Financial
Statements") needed to be restated. The need for a restatement arose from the
discovery and subsequent investigation by the Audit Committee (the "Investigation")
of the diversion of revenues payable to the Companyfrom certain licensees of its
Ragnarok Online game to the former Chairman and former controlling
shareholder of the Company, Mr. Jung Ryool Kim (the "former Chairman") . The
-16-
impact of the diversion was that such revenues were improperly omitted from the
Original Financial Statements .
In January 2006, the Audit Committee, with the assistance of its special Korean
counsel, Woo Yun Kang Jeong & Han ("Woo Yun"), its special United States
counsel, Cleary Gottlieb Steen & Hamilton LLP and Deloitte Anjin LLC
("Deloitte"), which was hired by Woo Yun to assist it on accounting matters,
completed the Investigation . On January 23, 2006, the Audit Committee presented to
the Company's board of directors and senior management, the final investigation
reports of Woo Yun and Deloitte, which summarized the results of the Investigation
(the "Investigation Reports") . [Emphasis Added]
37 . The Amended 2004 20-F further detailed the "areas" that resulted in the Restatemen t
and stated that the former Chairman - Defendant J . Kim - "systematically diverted certain payments
that were due to the company from the licensing of Ragnarok Online . . . by instructing licensees to
pay such amounts to bank accounts that were fraudulently established in the Company' s name" or
"established in the name of other companies under the control of the former Chairman ."
38. The Amended 2004 20-F explicitly linked the "diversion" of revenues by the former
Chairman to Gravity's improper accounting stating in pertinent part as follows :
The conclusions setforth in the reports address the following areas that resulted in
a restatement of the Original Financial Statements : (i) that the former Chairman of
the company systematically diverted certain payments that were due to the
company from the licensing of its Ragnarok Online game by instructing licensees
to pay such amounts to bank accounts that were fraudulently established in the
Company's name or established in the name of other Company's that were under the
control of the former Chairman . This diversion resulted in an understatement of
revenue in the original financial statements; (ii) expenses incurred by the Company
for the purchase of certain assets that were recorded as fixed assets of the company
but were actually acquiredfor the personal benefit of the former Chairman . This
improper use of the Company's funds resulted in fixed assets and related
depreciation being improperly recorded in the original financial statements ; and (iii)
the improper and intentional early recognition of certain revenue in connection
with the Company 's mobile games revenue and character merchandising,
animation and other revenue in the year ended December 31, 2004 . This
intentional manipulation of recorded revenue resulted in revenue being recorded
for the year ended December 31, 2004 that should have been deferred and
subsequently recognized in 2005 .
Based on the results of the Investigation, the Audit Committee recommended to the
Company's board of directors, and the board of the directors resolved that th e
-17-
Company will restate the Original Financial Statements, reflecting certain of the
material findings in the Investigation Reports, as soon as practicable, with the
assistance of a Korean affiliate of a major international accounting firm, which was
hired by the Company as a consultant to assist it in preparing the Restated Financial
Statements under accounting principles generally accepted in the United States, or
U .S . GAAP .
The Company has completed the preparation of the Restated Financial Statements,
which it is filing as Exhibit 18 to this Amendment No . 1 to our 2004 Annual Report
on Form 20-F . As discussed in Note 2 of the Notes to the Restated Financial
Statements, the Company's consolidated balance sheets as of December 31, 2003 and
2004 and its consolidated statements of operations, cash flows and change in
shareholders' equity for 2002, 2003 and 2004 have been restated from the Original
Financial Statements . Restatement adjustments are further described in Note 2 of the
Notes to the Restated Financial Statements . [Emphasis added . ]
39 . The Amended 2004 20-F set forth the magnitude of Gravity' s misstated 2002, 200 3
and 2004 financial statements and described the numerous ways in which the financial statement s
violated GAAP . The Amended 2004 20-F stated in pertinent part as follows :
The Company has restated its consolidated balance sheets as of December 31, 2003
and 2004 and its consolidated statements of operations, cash flows and change in
shareholders' equity for 2002, 2003 and 2004 from the Original Financial Statements
to reflect the following, resulting from the findings of the investigation :
(a) The diversion of revenues attributable to the Company by the former Chairman
during the years ended December 31, 2002, 2003 and 2004. These Restated
Financial Statements include such revenue in the period when it would have been
recognized by the Company, had the diversion not occurred . These amounts are
recorded as "Misappropriated funds receivable" in the restated consolidated balance
sheets as of December 31, 2003 and 2004 . In addition , the Restated Financial
Statements include the recognition of expense for royalty payments due to several
third parties relating to the Company 's Ragnarokgame that were not recognized as
expenses in the relevant periods as a result of the diversion of revenues by the
former Chairman . The Restated Financial Statements include such expenses as cost
of revenue or interest expense, as applicable, in the period when the related revenue
is recorded in the restated consolidated statement of operations for the years ended
December 31, 2002, 2003 and 2004 and as an amount payable to the relevant parties
in the restated consolidated balance sheets as of December 31, 2003 and 2004 .
(b) The misappropriation of certain assets, previously recorded as fixed assets in the
Company's consolidated financial statements . The Restated Financial Statements
include an adjustment from the Original Financial Statements related to the
purchase by the Company of certain assets that were recorded asfixed assets in the
Original Financial Statements . The Company determined, based on the Investigation
-18-
Reports, that these assets could not be identified and management and the audit
committee concluded that such assets should have been recorded as expense in the
Company's financial statements at their purchase date, as it is unlikely that the
Company received any benefit from the purchase of the assets . Additionally, the
Original Financial Statements included depreciation expense related to these assets
in the years ended December 31, 2003 and 2004 . Depreciation expenses have not
been recorded in the Restated Financial Statements for the years ended December
31, 2003 and 2004 as the costs of such assets are fully expensed at their acquisition
date in these statements .
(c) Improper and intentional early recognition of certain revenue in connection
with the Company's mobile games revenue and character merchandising,
animation and other revenue relating to products in the year ended December 31,
2004 . Accounting principles generally accepted in the United States of America
("US GAAP") requires that revenue should not be recognized until delivery of the
product or completion of service . The restated consolidated statement of operations
for the year ended December 31, 2004 include adjustments to reduce the amount of
revenue recognized in that year as the product contracted for had not been delivered
by year end.
(d) The impact of the above adjustments on foreign currency gains (losses ), net is
recorded in the Restated Financial Statements due to the timing difference in the
recognition of revenue and the receipt of the revenues by the Company .
(e) The impact of the above adjustments on the provision for income taxes has been
reflected in the year in which the items are recorded in the Restated Financial
Statements . Which consists of changes in the deferred tax assets and liabilities
resulting from the misappropriation by the former Chairman, and increases in
penalties and interest payable for inaccurate reporting of taxes in the years when the
diversion took place .
(f) The Company had incorrectly recorded certain foreign tax credits in prior
periods . Additionally, the Company had previously amended credits recorded in one
period by adjusting the balance of the credits at the end of the subsequent period .
The Restated Financial Statements now reflect the correct foreign tax credits in the
year in which they should have been recorded .
The Restated Financial Statements do not reflect all of the issues noted in the
Investigation Reports, as certain findings could not ultimately be corroborated
based on the available evidence . Subsequent to the discovery of the embezzlement,
the former Chairman paid W7 .8 billion to the Company in October 2005 . In
addition, the former Chairman has agreed to pay an additional amount to the
Company, in part to reimburse the Company for certain of the costs and expenses
incurred by the Company in connection with the Investigation . [Emphasis added. ]
-19-
40. The Amended 2004 20-F set forth the impact of the Restatement on Gravity' s
previously issued financial statements as follows :
The followingsct, fo :t . the impact on reported net iome(loss) as is result of theiterrrsdescriibed above
(In million. j Kore m id
2002
Net income (loss) as previously reporte d
(a) Adjustment due to diversion of revenue by the former Chairman including
related expenses
(b) Adjustments due to misappropriation of certain assets
(e) improper and intentional early recognition of revenue including related
expenses
(d) Foreign currency gains (losses) effect of the above adjustments
(e) Tax effect of the above adjustment s
(f) Error in rcc ording foreign tax credit
Total adiustmc n
Net income (locs ) as restated
W (496)
2003
2 004
-W 14,66v
W2u, 2n 1
231
-
6,50( ,
(277 )
ll4a )
18
( 75)
174
A- (322)
(4 ;1
(1,957)
242
4,471
W19_140
91
(180 )
(824 )
(1,144 )
W28,057
The following sets forth the impact on reported retained earnings as a result of the items discussed above :
Oil mdh-, '1 K!.rra ..
2003
Retained earning as previous I,: reported
(a) Adjustment due to diversion of revenue by the former Chairman including related expenses
(b) Adjustments due to misappropriation ofcertain assets
(c) Improper and intentional early recognition of revenue including related expenses
(d) Foreign currency gains (losses) effect of above adjustments
(e) Tax effect of the above adjustments
(F) Error in recording foreign tax credit
Total adjustments
Retained earning as restated
W12,916
6,???
(277 }
(26)
(2,032)
(2,212 )
242
4,644
wi%,5fi4
-20-
200 4
X442,11 7
7,167,
(190 )
(748 )
65
(582-)
3,50) )
k }5,61 7
The following, sets forth the impact on the Company's statements of operations as .a result of the items discussed above:
For the year ended December 31 .
2003
2002
(As
(In rrr[Tinn_s nfkurean tlr
Other
(A s
presitotros
re ported
resrated)
previously
reported
restated)
2,330
-
W22 .NU 1
1+
W29,727
43
X444,236
480
W4510 1
376
427
10,(X,7
1,738
5,685
1,024
42,431
6,866
12,712
1,185
49,515
6 .958
12,957
3,471
64,440
10,309
15,749
2,696
64,426
10,11 6
15,689
(27583)
(5,947)
16 .465)
(4,3091
(4,732 )
178
2,535
135
4 .250
(716)
4,402
(625 )
5,40 6
W 14,669
W 19,140
(248)
W29,201
(296 )
W' 8,057
pre.tousty
( As
re ported )
restored)
Revenue s
Online gamco rmalric- sn _
license tee , W 2,079
Mobi le game=;
Character merchandising,
anim aridother 427
1 dial nct rc :mies 9,816
Cost ofre"1:11L - 1,735
Operating L :penes 5,771
Other income rcxpcn,ei-interes t
expense (2,480)
2WA
(As
(As
(A s
inch'c c {cv)lent e li~rcig n
currency gran lotion 58
Income tax expense, 467
Equity in loss of re1tcc ;l join t
venture
Net income (loss) W (496)
76
542
-(322)
The following _ets forth the impact on the Company's balance sheet as a result of the items discussed above:
As tithe Year ended December 31 .
2003
(8 : ,ss /1,ois r fK,esm 11 , s,
Assets :
Accounts receivable , net
Misappropriated funds receivable-cu rent
Deferred expense
Current deferred income tax asset
2004
(As
prerinasiy
(As
(As
previously
reported )
restated)
reported )
(As
re stored )
W 6,988
651
W 7011
963
AXL 7,321
2,530
W 7,37 7
7 .48 2
2,58 8
504
536
2,684
1,692
2156
17,304
5,694
-
2,309
17,824
5,417
7,44 1
2 .258
40,098
14,951
2 .424
46,86 8
14 .76 0
Other current assets
Total current assets
Property and equipment. net
Misappropriated funds receivablePon current
Other non current asset,
Total assets
1,854
1,829
2,893
2,82 4
3X.28,765
W36,424
62,134
468,04 4
Liabilities :
Accounts Payable
Deferred income
Current portion of long-term debt
Accrued interest
Income tax payable
W 2,432
2,671
2,633
678
476
W 2,518
3,409
2 .630
744
1,109
~1. 3,576
4392
1 .278
271
478
W 3,74 2
5,639
1,15 0
31 8
1,17 2
Other current liabilities
160
324
26
9, 051
380
1,1 64
10,575
849
1,04 6
10,319
1,918
12,2'2 1
1,958
--
1,135
-
1,06 3
8
10,945
12 .916
10
13,96))
17,5 6 0
15,20 4
42.117
7
18,20 9
45,01 7
161
Total current liabilities
Long- term deferred income
Long-term debt
Long - term accounts payable
Other non current liabilities
Total liabilities
Retained earnings
(2 t
Accumulated other comprehensive los
Total shareholder ' s equity
Total liabilities and shareholder's equity
17, 820
wk28,765
(21
22,461
444 35,.424
141)
46,930
'62,134
(137 1
50,43 5
44) 8,644
41 . The Amended 2004 20-F provided additional detail on the Restatement and its impact
on the Company's financial statements stating in pertinent part as follows :
As a result of activities which necessitated the restatements to the Company's
Original Financial Statements, our total assets increased by W7, 659 million and
W6, 510 million in 2003 and 2004, respectively, from the previously reported
-21-
amounts in the Original Financial Statements principally due to the recognition of
Misappropriated funds receivable-non current of W7,441 million in 2003, and the
recognition of Misappropriated funds receivable-current of W7,482 million in 2004 .
This represents the amounts diverted by the former chairman and, therefore due to
the Company as of December 31, 2003 and 2004.
In addition , there were certain adjustments to deferred expense, accounts
receivable, net, current deferred income tax asset and other current assets in each
of the years presented.
Total liabilities
As a result of activities which necessitated the restatements to the Company's
Original Financial Statements, total liabilities increased by W3, 015 million and
W3,005 million in 2003 and 2004, respectively, from the previously reported
amounts, principally due to the following adjustments :
• Deferred income increased by W738 million and W7,247 million in
2003 and 2004, respectively, and long-term deferred income increased by
W469 million and W40 million in 2003 and 2004, respectively . In each
year, the adjustments are due to increases in initial license fees which are
being recognized over the relevant contract terms, resulting from the former
Chairman's diversion of licensee fee payments due to the Company and the
impact of the improper and early recognition of revenues relating to the
Company's mobile games and character merchandising, animation and other
revenues in 2004 ;
• Income tax payable increased by W633 million and W694 million
in 2003 and 2004, respectively , due to the recognition of certain tax penalties
as a result of the underpayment of income taxes in the relevant periods ; an d
• Long-term accounts payable increased by W1, 138 million and
W1,063 million in 2003 and 2004, respectively , due to the recording of
additional payments due to certain third parties as a result of the increase in
revenues in such year .
Effect on Consolidated Statements of Cash Flows :
As a result of activities which necessitated the restatements to the Company's
Original Financial Statements, Net cash provided by (used in) operating activities
increased W15 million, W106 million and W8 million in 2002, 2003 and 2004,
respectively, and Net cash provided by (used in) financing activities decreased by
the same amount in 2002, 2003 and 2004, respectively, from the previously reported
amounts in the Original Financial Statements, due to the reclassification between
Accrued interest in Cash flows from operating activities and Repayment of long-term
debt, as a result of the imputed interest rate relating to Long-term loan was changed .
-22-
In addition, on December 26, 2003, the Company borrowed loans of W4,600
million from three banks and repaid the same amount in five days which had not
been recorded in previously reported amounts in the Original Financial Statements .
Effect on Consolidated Statements of Change in Shareholders 'Equity :
As a result of activities which necessitated the restatements to the Company's
Original Financial Statements, total shareholders' equity increased by W173
million, W4,644 million and W3,505 million in 2002, 2003 and 2004, respectively,
from the previously reported amounts in the Original Financial Statements of
W(263)million, W 17,820 million and W46,930 million in 2002, 2003 and 2004,
respectively, to W(90) million, W22,464 million and W50,435 million in 2002, 2003
and 2004, respectively, principally due to the decrease in net loss in 2002 and
increase in net income in 2003 and 2004 . [Emphasis added .]
The Prospectus Contained Untrue Statements
Of Material Fact Concerning Ragnarok Onlin e
42. By the time of the IPO, Gravity was experi encing a signi fi cant slowdown in the
growth of Ragnarok Online peak concurrent users in its core markets of Korea, Japan and Taiwa n
(hereinafter referred to as the "Significant Markets"). Such markets accounted for more than 70% of
the Company's revenues through 2004 . The Prospectus omitted to state this material fact which wa s
required to be stated therein in order to make the statements made therein about Ragnarok Online no t
misleading . Furthermore, the slowing growth in Ragnarok Online peak concurrent users was a
negative trend which was material and required to be stated in the Prospectus pursuant to SE C
regulations but was not .
43 . Ragnarok Online and sales of the product were and are of material importance to
Gravity . The chart below reflects the growth in Gravity's revenues prior to the IPO :8
8 The amounts reflected in the chart have not been restated and reflect the amounts reported in the
Prospectus .
-23-
Gravity Co., Ltd
Total Revenue
For the ye ars ended December 31, 2001, 2002 and 2003
in millions of Koren Wo n
W50.00
W40.00
W30.00
W20.00
W 10.00
W0.00
2001
2002
200 3
The explosive growth evidenced by this chart above was primarily the result of the commercia l
launch of Ragnarok Online in August 2002 . Pre-IPO, Ragnarok Online accounted for 95% of th e
Company's revenues .
44. The Prospectus contained numerous positive statements about Ragnarok Online an d
the importance of the online game to the Company's business but failed to include the then presen t
state of demand for the game in the Significant Markets . For example, the Prospectus stated i n
pertinent part as follows:
We are a leading developer and distributor of online games in Japan , Taiwan and
Thailand based on the number of peak concurrent users. We are based in Korea
and our principal product, Ragnarok Online, is currently commercially offered in 19
markets, including Korea. Ragnarok Online recorded over 770,000 aggregate peak
concurrent users (defined as the sum of the highest number of users
simultaneously logged on to ourgames ' servers in each country) and over 400,000
average concurrent users (defined as the sum of the average number of users
simultaneously logged on to our games' servers in our key markets, which are Japan,
Taiwan/Hong Kong, Thailand, China and Korea) during the third quarter of 2004 .
We also offer a number of mobile games, which are played using mobile phones and
other mobile devices, participate in the production of a televised animation series ,
-24-
and license the merchandizing of character-related products based on our online
games . We intend to diversify our online game offering by developing online games
internally and publishing additional online games developed by third parties.
[Emphasis added.]
45. The Prospectus stated that Ragnarok Online was experiencing "continuin g
popularity" and attributed the Company's historical revenue growth to the online game . The
Prospectus stated in pertinent part as follows :
We attribute our revenue growth largely to our early entry into additional markets
since Ragnarok Online's commercial launch and the continuing popularity of
Ragnarok Online among users in the existing markets . [Emphasis added.]
The statement referenced above was misleading because it omitted to state that Ragnarok Online was
experiencing slowing in growth in the Significant Markets . In attributing Gravity's historical
revenue growth to Ragnarok Online, the Prospectus should have stated the present condition of the
market for Ragnarok Online - it was softening and the growth trends were slowing dramatically - i n
order to provide full and complete information .
46 . As demonstrated in the chart below, the growth in Gravity's "peak concurrent users, "
which serves as a proxy for the popularity of Gravity's online games and as an indicator of futur e
revenue growth, stalled prior to the IPO after rising considerably through the date of the most recen t
financial statements included in the Prospectus :
-25-
Gravity Co., Ltd
Peak Concurrent Users
September 30, 2004 was
the most recent date of the
financial data included in
the. Pmsnect s
900
700
600
iro
500
400
300
200
Q1 '03 Q3 '03 Q1'04 Q3'04 Q1'0 5
Q2'03 Q4'03 Q2'04 Q4'04 Q2'0 5
47 . These facts indicated that the growth in the Company' s online game revenue was
highly likely to deteriorate after the IPO . As noted in the chart below, after the IPO, the trend i n
Gravity's revenue changed radically :
Gravity Co., Lt d
Total Revenue
inmillbns ofKoren'Abn
W17,000.00
W16,500.00
W16,000.00
W15,500.00
W15,000.00
W14,500.00
W14,000.00
W13,500.00
W13,000.00
Ql'04 Q3'04 Q1'05
Q2'04
Q4'04
Q2'05
-26-
48 . The post offering decline in Gravity's revenue noted in the above chart was due, i n
material part, to the waning popularity and fewer number of Ragnarok Online users .9 This negative
trend was in existence at the time of the IPO and was required to be disclosed in the Prospectus .
49 . After the IPO, Gravity admitted that its Ragnarok Online subscription revenues in the
Significant markets were in a state of decline . In fact, just three months after the IPO, when it
announced its 2005 first quarter operating results in May 2005, Gravity disclosed that it s
"subscription revenue declined 18% [during the quarter] due to the continued decline ofRagnaro k
Online revenues in Korea ." [Emphasis Added]
The Prospectus Omitted To Include
Significant Factors that Made the IPO Speculative or Risky
50. Item 3 of Form F-l required the Prospectus to include information pursuant to Ite m
503 of Regulation S-K [17 CFR 229 .503] . Item 503 of Regulation S-K provides, in pertinent part :
[P]rovide under the caption "Risk Factors" a discussion of the most significant
factors that make the offering speculative or risky . This discussion must be concise
and organized logically. Do not present risks that could apply to any issuer or any
offering. Explain how the risk affects the issuer or the securities being offered .
51 . The Prospectus did not provide the information required by Item 3 of Form F-1 an d
Item 503 of Regulation S-K by omitting to state Gravity's material internal control deficiencies ove r
its financial reporting . In this regard, the Prospectus omitted to state that at the time of the IPO ,
Gravity had the following material weaknesses in its internal controls over financial reporting :
• Gravity did not maintain effective control environment thereby enabling the
Company's former Chairman to take numerous inappropriate actions resulting in the
Restatement ;
Lack of independent oversight and supervision controls ;
' As alleged herein, the post offering decline in Gravity's post-offering revenue was also due to the
pre-mature recognition of 2005 revenue in 2004 .
-27-
• Lack of controls over the reported revenues from Gravity' s oversea licensees;
• Lack of control over back accounts ;
• Lack of sufficient complement of personnel ;
• Lack of controls over the purchase and accounting for fixed assets ; and
• Lack of controls over the financial close and reporting process .
52 . Gravity's lack of internal controls over financial reporting made the IPO mor e
speculative and risky because the Company was unable to ascertain its true financial condition an d
lacked control over its finances and financial processes . The fact that Gravity had materia l
weaknesses with respect to its internal controls over financial reporting would have been viewed b y
investors as substantially altering the total mix of information available to investors .
53 . In the Amended 2004 20-F, Gravity admitted that it had material weakness in it s
internal controls over financial reporting at the time of the IPO . The 2004 Amended 20-F stated i n
pertinent part as follows :
Material Weaknesses in Internal Control Over Financial Reportin g
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting as such term is defined in Exchange Act
Rule 13a-l5(f) . Because of its inherent limitations, internal control over financial
reporting may not prevent or detect all misstatements . A material weakness as
defined under the Standards of the Public Accounting Oversight Board (United
States) is a control deficiency, or combination of control deficiencies, that results in
more than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected . Management identified the
following material weaknesses in our internal control over financial reporting (as
defined under Standards of the Public Accounting Oversight Standard Board (United
States) as of December 31, 2004 .
We did not maintain an effective control environment. Specifically, the Company
did not maintain a control environment adequate to encourage the prevention or
detection of the override of our controls or intentional misconduct, including the
embezzlement of revenues due to the Company, improper payment for assets not
otherwise purchased for the benefit of the Company, the intentional and
inappropriate early recognition of revenue and the preparation of false management
reports, accounting records, financial statements and documents together with forge d
-28-
invoices . The absence of effective control environment allowed the former
Chairman to take inappropriate actions that resulted in certain transactions not being
properly reflected in our consolidated financial statements for the years ended
December 31, 2002, 2003 and 2004 . Such intentional misconduct by the former
Chairman included the preparation of false accounting records and documents to
deceive accounting personnel under his supervision, other members of senior
management, our Board of Directors and our independent registered public
accountants . Additionally, the lack of an effective control environment allowed our
lines of communication among, and our monitoring of, our operations and
accounting personnel, including the former Chairman, to be ineffective in preventing
or detecting these instances of intentional misconduct. Taken as a whole, our control
environment did not adequately emphasize appropriate judgment, skepticism and
objectivity, which the Company believes contributed to the events which necessitated
the restatements .
This control environment material weakness contributed to the fraudulent activity
described above, which in turn resulted in the restatement of our consolidated
financial statementsfor the years ended December 31, 2004, 2003 and 2002 and
adjustments to our 2005 consolidated financial statements . Additionally, this control
environment material weakness could result in misstatements of any of our financial
statement accounts that would result in a material misstatement to the annual
consolidated financial statements that would not be prevented or detected .
Accordingly, our management has determined that this control deficiency constitutes
a material weakness . This material weakness in our control environment
contributed to the existence of the following additional material weaknesses :
• Lack of independent oversight and supervision controls. The
Company's Audit Committee and the system of internal control over
financial reporting established by the Audit Committee failed to recognize
and detect the fraudulent activities by the former Chairman and certain
member of the senior management . The Company did not have adequate
controls related to the prevention and detection of fraud, for example,
corporate compliance programs and whistleblower hotlines.
• Lack of controls over the reported revenues from our overseas
licensees . The Company did not have controls designed to detect underreporting of amounts due to the Company by overseas licensees .
• Lack of controls over bank accounts. The former Chairman was able
to open overseas bank accounts, with the help of a Company employee
without appropriate monitoring, which contributed to the former Chairman's
ability to carry on fraudulent activities without being detected. In addition,
the former Chairman had access to the Company 's accounts without
oversight, which allowed him to use Company accounts and transferfunds
out of such accounts without proper authorization .
-29-
• Lack of sufficient complement ofpersonnel . The Company did not
maintain a sufficient complement ofpersonnel with an appropriate level of
accounting knowledge, experience and training in the selection, application
and implementation of U .S . GAAP commensurate with the Company's
financial reporting requirements under the Exchange Act .
• Lack ofcontrols over the purchase and accountingfor fixed assets .
The Company did not have adequate authorization controls to ensure that
assets purchased and paid for by the Company were in fact for the benefit
of the Company and did not have adequate controls to verifyand ensure
that assets recorded in the Company's balance sheet were in fact in
possession of the Company .
• Lack of controls over the financial close and reporting process . We
did not maintain effective controls, including monitoring, over our financial
close and reporting process . Specifically, we do not have adequately
designed controls to ensure the completeness, accuracy and restricted
access to spreadsheets used in the period-end financial closing process.
This control deficiency could result in errors in the performance of
consolidations and the preparation of U.S. GAAPfinancial statements and
allow our employees manipulate financial results and override controls .
The control deficiencies described above resulted in the restatement of the
Company's consolidated financial statementsfor the years ended December 31,
2004, 2003 and 2002 and adjustments to our 2005 consolidated financial statements .
Additionally, each of the control deficiencies described above could result in a
misstatement in any of our financial statement accounts or disclosures that would
result in a material misstatement in the Company's consolidated financial statement
that would not be prevented or detected .
Accordingly, the Company' s management has determined that each of these
control deficiencies constitute material weaknesses . [Emphasis added .]
Post IPO Announcements
54 . On May 12, 2005, Gravity issued a press release announcing its financial results fo r
the first quarter of 2005, the period ended March 31, 2005 . For the first quarter, the Company
reported that revenue was $15 .8 million (U .S.) compared to $16 .4 million in the forth quarter o f
2004 . The Company reported that subscription revenue was up 14% due to R .O.S.E. Online and
"positive seasonal factors ." Importantly, the Company noted that this increase in subscriptio n
revenue was "more than offset" by "lower revenue from the animation business ." Moreover, the
-30-
Company reported that subscription revenue on a year over year basis declined 18% stating i n
pertinent part :
Subscription revenue was up 14% in the first quarter of 2005 compared to the fourth
quarter of 2004 due to the addition of revenue from Gravity's newly launched
R.O.S .E Online and positive seasonal factors. However, lower revenue from
animation business more than offset the rise in subscription revenue . On a year
over year basis, subscription revenue declined 18% due to the continued decline of
Ragnarok Online revenues in Korea . Royalties and license fees from overseas
markets were $11 .1 million in both the first quarter of 2005 and the fourth quarter of
2004. [Emphasis added .]
55 . In response to the announcement of "lower revenue" in Gravity's animation busines s
and the "continued decline" in Ragnarok Online revenues in Korea, the price of Gravity ADS s
plunged from $9 .24 per ADS to $5 .60 per ADS, on more than ten times the normal trading volume .
56. On October 18, 2005, Gravity issued a press release announcing that it had
commenced an investigation into certain "irregular" activities because it had been informed b y
EZER, which had acquired majority interest in the Company from Defendant J . Kim, that certain
royalty payments paid to Gravity from licensees of Ragnarok Online were not accounted for in th e
Company's financial statements . The Company also stated that Defendant J . Kim acknowledge d
that "approximately $6 million were diverted over the past few years" and voluntarily pai d
approximately $7.3 million (representing the dive rted funds plus interest at 6% per annum) to th e
Company on October 17, 2005 .
57 . In response to the announcement that Defendant J . Kim had "diverted" royalty
payments , the p ri ce of Gravity ADSs declined from $7.62 per ADS to $6 .96 per ADS .
58 . On November 10, 2005, Gravity issued a press release announcing that its Audi t
Committee had determined that the Company's audited consolidated financial statements as of an d
for each of the years ended December 31, 2002, 2003 and 2004 and its unaudited quarterly financia l
-31-
statements as of and for each of the three months ended March 31, 2005, and June 30, 2005 needed
to be restated, and, as a result, such financial statements "should not be relied upon."
59 . In response to the announcement that the Company would be restating its financia l
statements, the price of Gravity ADSs declined to $6.44 per ADS .
COUNT I
Violations of Section 11 of the Securities Act
Against All Defendants
60 . Plaintiff incorporates ¶T 1-59 by reference herein . This Count is brought pursuant to
Section 11 of the Securities Act, 15 U .S .C. §77k and is assert ed against all Defendants . For
purposes of this Count, Plaintiff does not claim that Defendants committed intentional or reckles s
misconduct or that Defendants acted with scienter or fraudulent intent .
61 . The Registration Statement for the IPO was inaccurate and misleading, containe d
untrue statements of material facts, omitted facts necessary to make the statements made therein no t
misleading and omitted to state material facts required to be stated therein.
62. Defendant Gravity is the issuer of the common stock underlying the ADSs purchase d
by Plaintiff and the Class . As such, Gravity is strictly liable for the materially inaccurate statements
contained in the Registration Statement and the Prospectus and the failure of the Registratio n
Statement and Prospectus to be complete and accurate .
63 . The Individual Defendants each signed the Registration Statement either personall y
or through an Attorney-in-Fact and/or caused its issuance . The Individual Defendants each had a
duty to make a reasonable and diligent investigation of the truthfulness and accuracy of th e
statements contained in the Registration Statement. They had a duty to ensure that such statements
were true and accurate, that there were no omissions of material facts that would make th e
statements misleading and that the documents contained all facts required to be stated therein . In the
-32-
exercise of reasonable care, the Individual Defendants should have known of the materia l
misstatements and omissions contained in the Registration Statement and also should have known o f
the omissions of material fact necessary to make the statements made therein not misleading . As
such, the Individual Defendants are liable to the Plaintiff and the Class .
64 . The Underwriter Defendants were each underwriters, as that term is used in Sectio n
11(a)(5) of the Securities Act, with respect to the IPO and the Company 's securities sold through the
Registration Statement . The Underwriter Defendants were required to investigate with due diligenc e
the representations contained therein to confirm that they did not contain materially misleadin g
statements or omit mate rial facts. None of the Underwriter Defendants made a reasonabl e
investigation or possessed reasonable grounds for the belief that the statements described herein ,
which were contained in the Registration Statement and Prospectus, were true, were withou t
omission of any material facts, and/or were not misleading .
65 . By reasons of the conduct herein alleged, each Defendant violated Section 11 of th e
Securities Act.
66. Plaintiff acquired Gravity ADSs traceable to and in reliance on, the Registratio n
Statement and without knowledge of the untruths and/or omissions alleged herein . Plaintiff
sustained damages when the p rice of Gravity ADSs declined substantially due to mate rial
misstatements in the Registration Statement and Prospectus .
67 . This action was brought within one year after the discovery of the untrue statement s
and omissions and within three years of the date of the IPO .
-33-
COUNT I I
Violations of Section 12(a)(2) of the Securities Act
Against All Defendants
68 . Plaintiff incorporates ¶¶ 1-67 by reference herein. This Count is brought by Plaintif
f
pursuant to Section 12(a)(2) of the Secu rities Act, 15 U.S.C. §771, on behalf of all purchasers o f
Gravity ADSs in the IPO . For purposes of this Count, Plaintiff affirmatively states that it does not
claim that Defendants committed intentional or reckless misconduct or that Defendants acted wit h
scienter or fraudulent intent .
69. Defendants were sellers and offerors and/or solicitors of purchasers of the ADS s
offered pursuant to the Prospectus . Defendants issued, caused to be issued, and/or signed th e
Registration Statement in connection with the IPO . The Registration Statement contained a
Prospectus, which was used to induce investors, such as the Plaintiff and the other members of th e
Class, to purchase Gravity ADSs .
70. The Prospectus contained untrue statements of mate rial facts, omi tted to state other
facts necessary to make the statements made not misleading, and omitted material facts required t o
be stated therein. The Individual Defendants' actions of solicitation included participating in th e
preparation of the false and misleading Prospectus and in "Road Shows" to promote the IPO .
Gravity and the Underwriter Defendants, acting through their employees, agents and others, solicite d
such purchases for their personal financial gain through the preparation and dissemination of the
Prospectus .
71 . Pursuant to the Underwriting Agreement, the Underwriter Defendants purchased a
total of 8 million Gravity ADSs at the public offering price, less an underwriting discount in the IPO .
Of the 4 million shares, Credit Suisse sold at least 5,200,000 ADSs, Daewoo sold at least 1,600,00 0
ADSs, CIBC sold at least 600,000 ADSs and CLSA sold at least 600,000 shares .
-34-
72. The Underwriter Defendants pa rticipated in the preparation and dissemination of th e
false and misleading Prospectus for their own financial benefit . But for their participation in th e
IPO, including their solicitation as set forth herein, the IPO could not and would not have been
accomplished . Specifically, the Underwriter Defendants :
(a) made the decision to conduct the IPO and do it at the price set forth in th e
offering documents . The Underwriter Defendants drafted, revised and/or approved the Prospectus .
The Prospectus was calculated to create interest in Gravity ADSs and was widely distributed by or
on behalf of these Defendants for that purpose ;
(b) finalized the Prospectus and caused it to become effective ; and
(c) conceived and planned the IPO and orchestrated all activities necessary to
affect the sale of these securities to the investing public, by issuing securities, promoting th e
securities and supervising their distribution and ultimate sale to the investing public.
73 . As set forth more specifically above, the Prospectus contained untrue statements o f
material fact and omitted to state material facts necessary in order to make the statements, in light o f
circumstances in which they were made, not misleading.
74. Plaintiff and the other Class members did not know, nor could they have known, o f
the untruths or omissions contained in the Prospectus .
75. The Defendants named in this Count were obligated to make a reasonable and diligen t
investigation of the statements contained in the Prospectus to ensure that such statements were tru e
and that there was no omission of material fact required to be stated in order to make the statement s
contained therein not misleading . None of the Defendants named in this Count made a reasonabl e
investigation or possessed reasonable grounds for the belief that the statements contained in th e
-35-
Prospectus were accurate and complete in all material respects . Had they done so, these Defendants
could have known of the materi al misstatements and omissions alleged herein .
76 . This claim was brought within one year after discovery of the untrue statements an d
omissions in the Prospectus and within three years after Gravity ADSs were sold to the Class i n
connection with the IPO .
77. By reason of the misconduct alleged herein, the Defendants named in this Coun t
violated Section 12(a)(2) of the Securities Act and are liable to Plaintiff and Class members wh o
purchased or acquired Gravity ADSs in the IPO pursuant to the Prospectus, each of whom has bee n
damaged as a result of such violation .
COUNT II I
Violations of Section 15 of the Securities Act
Against the Individual Defendants
78 . Plaintiff incorporates ¶¶ 1-77 by reference herein . This Count is asserted by Plaintiff
against all the Individual Defendants . For purposes of this Count, Plaintiff affirmatively states that i t
does not claim that Defendants committed intentional or reckless misconduct or that Defendants
acted with scienter or fraudulent intent .
79 . Throughout the Class Period, the Individual Defendants acted as controlling person s
of Gravity within the meaning of Section 15 of the Securities Act . By reason of their stoc k
ownership, senior management positions and/or directorships at the Company, as alleged above ,
these Defendants, individually and acting pursuant to a common plan, had the power to influenc e
and exercised the same to cause Gravity to engage in the conduct complained of herein . By reaso n
of such conduct, the Individual Defendants are liable pursuant to Section 15 of the Securities Act .
-36-
Materially False and Misleading
Statements Issued During the Class Perio d
80 . For the purposes of this section of the Complaint, the term "Defendants" refers onl y
to Defendants Gravity, R . Kim, Seo, J . Kim and Moon .
81 . The statements referenced in ¶¶29, 33, 41, 44, 45 and 50 from the Registratio n
Statement and the Prospectus are incorporated herein by reference . These statements wer e
materially false and misleading when made for the reasons set forth above .
82 . On March 11, 2005, Gravity filed a Form 6-K with the SEC which was signed b y
Defendant Seo . The Form 6-K set forth Gravity's preliminary Balance Sheet and Income Statemen t
summaries for the fourth quarter and year ended December 31, 2004 . The Company reported that
Gravity's preliminary net income for the fourth quarter of 2004 was W8,057 million, or
approximately 50% more than the net income Gravity reported in the Prospectus for the third quarte r
ended September 30, 2004 . For the fourth quarter of 2004, the Company reported that it ha d
"entered into animation contracts in Taiwan and Thailand for US $700,000 and US $100,00 0
respectively."
83. The statements referenced in ¶ 82 were each materially false and misleading becaus e
they failed to disclose and misrepresented the following material adverse facts including :
(a) that Gravity was materially misrepresenting its financial performance as it s
financial statements for the quarter and year ended December 31, 2004, were materially misstate d
and violated numerous provisions of U .S. GAAP, as detailed herein;
(b) that Gravity was intentionally recognizing revenue in violation of U. S . GAAP
and the Company's publicly stated accounting policies and that this improper practice overstate d
Gravity's 2004 reported revenues by hundreds of millions of Korean Won, as detailed herein ;
-37-
(c) that Gravity was knowingly or recklessly reporting foreign tax credits whic h
overstated Gravity' s 2004 net income by W824 million ;
(d) that Gravity was knowingly or recklessly reporting certain fixed assets that i t
neither possessed nor controlled;
(e) that Gravity was knowingly or recklessly failing to recognize W403 million i n
revenue in 2004 that Defendant J . Kim "diverted" ; and
(f) that Gravity was knowingly or recklessly reporting mate rially misstated
foreign currency gains and losses, accounts receivable, deferred income tax assets, other curren t
assets, deferred income, income tax provisions, income taxes payable and shareholders' equity ; and
(g) that Gravity utilized mate rially deficient internal controls to compile its post
offering financial results, including: (a) inadequate controls related to the prevention and detection o f
fraud; ( b) inadequate controls over repo rted revenues from overseas licensees ; ( c) inadequate
controls over bank accounts; (d) personnel with an inapprop riate level of accounting knowledge,
expe rience and training in the selection, application and implementation of U .S. GAAP ; (e)
inadequate controls over the purchase and accounting for fixed assets ; and (f) inadequate controls to
ensure the completeness , accuracy and restricted access to spreadsheets used in the pe riod-end
financial closing process.
84 . On March 29, 2005, Gravity issued a press release indicating that it had "reshuffle d
its management" with the Board appointing Defendant R . Kim, the Company's former CEO an d
Board member, as Gravity's first-ever Chief Strategy Officer, or CSO, to be responsible fo r
Gravity's global operations . In addition , Defendant Yoon was elected to replace Defendant R . Kim
as Gravity's new CEO .
-38-
85 . On March 31, 2005, Gravity held a conference call with securities analysts to quel l
investor concerns about the changes in Gravity's management on the heels of its IPO . On the call,
Defendant Yoon stated :
I'm sure there was a lot of concerns among investors about the abrupt management
change, especially when the stock price is plummeting. However, I'd like to assure
you that change should definitely generate very strong positive results in the near
future and it will definitely solidify Gravity's future position . The change has
basically two purposes . Number one, Richard Kim, as you know, stepped down as
CEO and changes his position to CSO which mean Chief Strategic Officer . As you
know, Gravity already is not a small company anymore . With global operations
covering 24 countries and with more than 500 people to manage, Mr . Kim has
expressed his wishes to focus on the areas where he really excels, which is global
operations and strategic area. His more focused approach from now will definitely
generate a great positive international result by making the best use of his assets and
capability. And secondly, Chairman of the Board, Mr. Kim also stepped down as the
representative director . And he will just remain as the Chairman of the Board and
still the largest shareholder . This is also a great step toward Chairman Kim's strong
belief that ownership and the management should be separated, especially at this new
stage after IPO . However, Chairman Kim will serve as a great visionary and a
supporter of Gravity for a very long, long time . Mr . Kim, Mr . Richard Kim and I
will make a great management leader group along with the best of the best
management crew we would like to recruit in the near future, which will cover
Marketing, HL and Financial and other important areas . So, we would like to raise
the level of the management to the global standard and best practice .
86 . Then, on May 12, 2005, Gravity issued a press release announcing its financial result s
for the first quarter of 2005, the period ended March 31, 2005 . For the first quarter, the Company
reported that revenue was $15 .8 million (U .S.) compared to $16 .4 million in the fourth quarter o f
2004 . The Company reported that subscription revenue was up 14% due to R .O .S .E. Online and
"positive seasonal factors ." Importantly, the Company noted that this increase in subscriptio n
revenue was "more than offset" by "lower revenue from the animation business ." Moreover, the
Company reported that subscription revenue on a year over year basis declined 18% stating i n
pertinent part :
Subscription revenue was up 14% in the first quarter of 2005 compared to the fourth
quarter of 2004 due to the addition of revenue from Gravity's newly launched
R.O.S.E Online and positive seasonal factors. However, lower revenue from
-39-
animation business more than offset the rise in subscription revenue . On a year
over year basis, subscription revenue declined 18% due to the continued decline of
Ragnarok Online revenues in Korea . Royalties and license fees from overseas
markets were $11 .1 million in both the first quarter of 2005 and the fourth quarter of
2004 . [Emphasis added.]
87 . In response to this announcement, the price of Gravity ADSs plunged, on more tha n
ten times the normal trading volume, to an all time low of $5 .60 ADS. Accordingly, just three
months after its IPO, the price of Gravity's ADSs declined by more than 70% from the Class Period
high IPO price of $13 .50 .
88 . As illustrated in the chart below, the decline in Gravity's first quarter 2005 profit s
was directly attributable to the precipitous, 57% drop in its mobile, character merchandising ,
animation and other revenue during the quarter :
Gravity Co ., Ltd.
Character Merchandising, Animation and Other Revenue
in millions o f Koren Won
W2,000.00
W 1,501a00
W1,000.00
W500 .00
W0 .00
Ql '04 Q2'04 Q3 '04 Q4'04 Q1 '0 5
89. At the end of the Class Period, when it filed the Amended 2004 20-F, Gravity
admitted that its 2004 revenues were overstated due to the "Improper and intentional early
recognition of certain revenue in connection with the Company 's mobile games revenue an d
-40-
character merchandising, animation and other revenue relating to products in the year ende d
December 31, 2004." [Emphasis added.]
90 . On May 13, 2005, Gravity filed a Form 6-K with the SEC that announced its results
for its first quarter ended March 31, 2005 . For the quarter, the Company reported a net income o f
W7,243 million compared to net income of W8,395 million in the prior year period .
In addition, the Form 6-K included following statements by defendants Yoon and Seo :
David Woong-Jin Yoon, Chief Executive Officer of Gravity, commented, "While we
continued to execute on our business in the first quarter, actual quarter results came
in lower than expected. The sluggish trends Gravity was impacted by appear to be
in line with domestic market weakness reported recently by other companies in our
industry. We remain confident, however, in our fundamental business and expect to
regain traction as we move forward and build on the strength of our titles worldwide
and growing global demand for online games ."
Kwan Shik Seo, Chief Financial Officer of Gravity, said, "We currently expect that
several issues, however, including increasing competition in Korea, will continue to
impact our results in the second quarter and for the full year 2005 . As a result, we
now expect our full-year 2005 revenue will be approximately US$75 .1 million, with
a pre-tax profit target of US$33 .2 million reflecting both the lowered revenue
expectations and Gravity's higher, post- IPO cost base . This would represent
revenue growth of 17% over 2004, which will be primarily caused by R.O.S.E.
Online royalty and license revenue in the second ha lf of this year and stronger RO
royalty and license revenuefrom newly commercialized markets. As for the second
quarter of 2005, due to increasing domestic competition and pricing pressure, we
expect revenue will decline by 3% compared to the first quarter, to approximately
US$15 .3 million, with pre-tax profit of approximately US$5 .9 million, down
approximately 19% compared to the first quarter 2005 or down 33% compared to the
second quarter of 2004 ." [Emphasis added.]
91 . The statements referenced above in ¶90 were each materially false and misleading fo r
the reasons set forth in ¶83 .
92 . On June 30, 2005, Gravity filed its Annual Report on Form 20-F with the SEC for th e
period ended December 31, 2004 (the "2004 20-F") . The 2004 20-F was signed by defendant Yoon ,
affirmed the Company's previously issued financial results for the year ended December 31, 2004 ,
-41-
and represented that the Company's financial statements for the years ended December 31, 2002 ,
2003 and 2004 had been prepared in accordance with U. S. GAAP . The 2004 20- F stated in pertinent
part as follows :
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("US GAAP") .
Revenue Recognition
Online games - subscription revenu e
Prepaid online game subscriptions are deferred and recognized based upon their
actual usage .
Online games -royalties and license fees
The Company licenses the right to sell and distribute its games in exchange for an
initial prepaid license fee and guaranteed minimum royalty payments . The prepaid
license fee revenues are deferred and recognized ratably over the license period . The
guaranteed minimum royalty payments, which are currently only paid in China, are
deferred and recognized as the royalties are earned . In addition, the Company
receives a royalty payment based on a specified percentage of the licensees' sales .
These royalties, that exceed the guaranteed minimum royalty, are recognized on a
monthly basis, as the related revenues are earned by the licensees .
Property and equipmen t
Property and equipment are stated at cost, less accumulated depreciation .
Depreciation for equipment, furniture and fixtures, vehicles, capital lease assets and
purchased software is computed using the straight-line method over the following
estimated useful lives :
Building
Computer and equipment
Furniture and fixtures
Software
Vehicles
Capital lease assets
-42-
40 years
4 year s
4 years
3 years
4 years
4 years
Leasehold improvements are amortized on a straight-line basis over the estimated
useful life of the assets or the lease term, whichever is shorter .
Significant renewals and additions are capitalized at cost . Maintenance and repairs
are charged to income as incurred.
Income taxe s
The Company accounts for income taxes under the provisions of SFAS No . 109,
Accounting for Income Taxes . Under SFAS No . 109, income taxes are accounted for
under the asset and liability method . Deferred taxes are determined based upon
differences between the financial reporting and tax bases of assets and liabilities at
currently enacted statutory tax rates for the years in which the differences are
expected to reverse .
A valuation allowance is provided on deferred tax assets to the extent that it is more
likely than not that such deferred tax assets will not be realized . The total income tax
provision includes current tax expenses under applicable tax regulations and the
change in the balance of deferred tax assets and liabilities .
93 . The statements referenced above in ¶92 were each materially false and misleading fo r
the reasons set forth in ¶83 .
94. On August 22, 2005, Gravity filed a Form 6-K with the SEC that announced its
results for its second quarter ended June 30, 2005 . For the quarter, the Company reported a ne t
income of W 1,942 million compared to net income of W7,448 million in the prior year period. The
Form 6-K, which was signed by John Chung, Gravity's "Investment Relations Officer," also stated,
in pertinent part as follows :
Revenue for the second quarter of 2005 was US$13 .3 million compared to US$15 .6
million in the first quarter and US$15 .3 million for the second quarter of 2004. This
represents a decline of 15 .0% and 13 .3%, respectively.
Royalties and license fees from overseas markets, comprising 71 .4% of our total
revenues, were US$9 .5 million in the second quarter of 2005 showing a 14 .0%
decline compared to the first quarter of 2005 and a 13 .2% decline compared to the
second quarter of 2004 . The reasonfor the decline in royalties in overseas market
for the second quarter of 2005 was due primarily to increased competition in major
markets . Subscription revenue, comprising 20% of our total revenues, was US$2 .7
million in the second quarter of 2005 which decreased 30 .1% compared to the first
-43-
quarter of 2005 and 30.9 % as compared to the second quarter of 2004, which we
believe was due to increased competition in Korea and a weak market reception for
the Ragnarok Online update in Korea that was conducted at the end of March
2005 . Mobile revenue, comprising 2 .5% of our total revenues, was US$0 .3 million
in the second quarter of 2005, representing a 97 .1 % increase compared to the first
quarter of 2005 and a 176 .6% increase compared to the second quarter of 2004 .
Other revenues, comprising 6.1% of our total revenues, were US$0 .8 million in the
second quarter of 2005, representing a 26 .7% increase compared to the first quarter
of 2005, or 80.4% increase compared to the second quarter of 2004 . We attribute
this increase to an increase in animation revenues .
Cost of revenues and operating expenses increased 30 .7% to US$10 .2 million in the
second quarter of 2005 from US$7 .9 million in the first quarter of 2005 due primarily
to research and development expenses of US$1 .5 million, which represent the
payment of a license fee for publishing a casual online game portal, STYLIA . Total
license fees of STYLIA were US$3 .0 million and the remaining US$1 .5 million will
be paid after open bata testing and commercialization and it will be capitalized . This
also represents a 85 .5% increase from our cost of revenues and operating expenses of
$5 .5 million in the second quarter of 2004 .
Pre-tax profit for the second quarter of 2005 was US$2 .8 million, compared to
US$7 .2 million for the first quarter of 2005 and US$8 .6 million for the second
quarter of 2004 .
Net income for the second quarter of 2005 was US$1 .9 million or $0 .07 per ADS on
a diluted basis, compared to US$5 .4 million or US$0.22 per ADS on a diluted basis
for the first quarter of 2005 and US$7.3 million or US$0 .33 per ADS on a diluted
basis for the second quarter of 2004 . Net income described above was calculated
using the tax rate of 24 .75% assuming that we may fail to be designated as a venture
company under Korean law for the fiscal year 2005 and thus would not be entitled to
the benefit of a 50% tax reduction . Gravity plans to renew its designation as a
venture company, the result of which is expected to be known in September 2005 . If
Gravity is successful in renewing its designation as a venture company, it expects to
continue to enjoy the 50% reduction in corporate income tax rate through 2006 and
its net income would be US$6.4 million for the first quarter of 2005 and US$2 .2
million for the second quarter of 2005 . [Emphasis added .]
In addition, the Form 6-K included following statements by defendant Yoon :
This was a challenging quarterfor Gravity as we faced increased competition in
key markets for Ragnarok Online, lower than expected Ragnarok Online update
results in Korea, and delayed commercialization and unfavorable market
conditions for R. O.S.E. Online. We plan to focus more on the casual game market
by publishing quality casual games produced by other game companies . In addition,
we are planning to expand our publishing business . However, because casual games
have shorter lifecycles than MMORPGs, a lower success-rate and an unpredictable
popularity-cycle, we will continue to update our principal game title, Ragnarok
-44-
Online. Although results from updates at the end of 2004 and in the first half of
2005 did not meet our expectations, we believe updates continue to help us to
retain existing users, attract new users, and maximize the lifecycle of Ragnarok
Online . Ragnarok Online is currently commercialized in 20 countries worldwide.
We continue to increase the number of commercialized markets for Ragnarok Online
and plan to launch into new countries in Latin America and Europe . We believe that
our expansion into new markets will extend the lifecycle of Ragnarok Online and
contribute to the geographical diversification of our revenue source . Concurrently,
we are doing our best to introduce commercialization of Requiem and Ragnarok
Online 2 as scheduled . [Emphasis added.]
95 . The statements referenced above in ¶94 were each materially false and misleading fo r
the reasons set forth in ¶83 .
96 . On July 1, 2005, Gravity announced that it was convening an "Extraordinary Genera l
Meeting of Shareholders" on August 10, 2005 .
97. On July 15, 2005, Gravity announced that it rescheduled the Extraordinary General
Meeting of Shareholders to August 23, 2005 .
98 . On July 22, 2005, Gravity announced that it has appointed Mr . William W . Song to
replace Defendant Seo as the Company's CFO and that Mr . John C . Chung was appointed as its
Investors Relations Officer . Gravity also announced that Defendant Seo would continue with hi s
responsibilities "for overall investor relations, financial reporting, and improving and enhancin g
internal control over financial reporting in compliance with Section 404 of the Sarban es-Oxley Act."
99 . On July 28, 2005, Gravity filed a Form 6-K with the SEC announcing that it did no t
expect to achieve its earnings targets for the second quarter of 2005 and the 2005 year :
David W. Yoon, CEO at Gravity, commented "We have come to realize that our FY
2005 revenue target of US$75 .1 million and a pre-tax target of US$33 .2 million will
be difficult to meet primarily due to the following reasons : increased competition in
key markets for Ragnarok Online, lower than expected Ragnarok Online update
results in Korea, and delayed commercialization and unfavorable market conditions
for R.O.S.E. Online ." [Emphasis added.]
100 . On August 8, 2005, Gravity announced that it rescheduled the Extraordinary Genera l
Meeting of Shareholders to September 7, 2005 .
-45-
101 . On August 19, 2005, Gravity announced that Defendant R . Kim resigned from hi s
position as CSO and Board member .
102 . On August 23, 2005, Gravity announced that it rescheduled the Extraordinary Genera l
Meeting of Shareholders to September 21, 2005 .
103 . On August 30, 2005, Gravity announced that Defendant J . Kim sold his entire
controlling interest in the Company to EZER. Upon this announcement, the price of Gravity's ADS s
rose dramatically, from near its Class Period low of $6 .82 per ADS on August 29, 2005, to $12 .1 4
per ADS on August 30, 2005 .
104. On September 13, 2005, Gravity announced that Mr . Il Young Ryu, CEO of EZER,
would be appointed Chairman and joint-CEO at the Extraordinary General Meeting of Shareholder s
on September 21, 2005 .
105 . On September 26, 2005, Gravity announced that as a result of its September 21, 200 5
Extraordinary General Meeting of Shareholders, Mr . Ryu Il Young was elected as the Company' s
new Board Chairman and CEO . Defendant Yoon, Gravity's preceding CEO resigned, but wa s
expected to remain as a Director and act as the Company's President . In addition to Mr . 11, Gravity
elected four new Directors, and Gravity announced that Myung Whan Suh, Chan Joong Park, S o
Young Choi, Jong Mahn Park, Mu Sik Jung, and Hyung Oh Yoo each resigned from thei r
Directorships .
106 . On that date, Gravity also announced that on September 21, 2005, it entered into a
renewable six month consulting agreement with Defendant J . Kim to serve as the Company' s
"Internal Counselor ." Pursuant to the agreement, Defendant J . Kim was to receive W 100 million pe r
year and other fringe benefits and reimbursement of expenses .
-46-
107 . On October 18, 2005, Gravity issued a press release announcing that it ha d
commenced an investigation into certain "irregular" activities because it had been informed b y
EZER, which had acquired majority interest in the Company from Defendant J . Kim, that certain
royalty payments paid to Gravity from licensees of Ragnarok Online were not accounted for in th e
Company' s financial statements . The Company also stated that Defendant J. Kim acknowledge d
that "approximately $6 million were diverted over the past few years" and voluntarily paid
approximately $7 .3 million (representing the diverted funds plus interest at 6% per annum) to the
Company on October 17, 2005.
108 . In response to this announcement, the price of Gravity ADSs declined from $7 .62 per
ADS to $6 .96 per ADS .
109 . On November 10, 2005, Gravity issued a press release announcing that its Audit
Committee had determined that the Company's audited consolidated financial statements as of an d
for each of the years ended December 31, 2002, 2003 and 2004 and its unaudited quarterly financia l
statements as of and for each of the three months ended March 31, 2005, and June 30, 2005 neede d
to be restated, and, as a result, such financial statements "should not be relied upon ."
110 . In response to this announcement, the price of Gravity ADSs declined to $6.44 pe r
ADS .
111 . Gravity also announced that on November 7, 2005, Defendant Seo resigned from hi s
position as the Company's Corporate Controller for "personal reasons ." In addition, the Compan y
announced that on November 11, 2005, Gravity was expected to hold a Board meeting to vote on th e
termination of Defendant Yoon .
112 . On December 20, 2005, Gravity announced that Defendant Yoon resigned as a
member of the Board on December 6, 2005 .
-47-
113 . On January 6, 2006, Gravity announced that : (a) Defendant Seo indicated his
intention to resign as a Board member effective on January 8, 2006 ; (b) Mr. Song resigned from his
position as CFO for "personal reasons" on December 27, 2005 ; and (c) Mr . Chung resigned from his
position as the Company's Investor Relations Officer .
114 . On January 24, 2006, Gravity announced that on January 23, 2006, its Audit
Committee presented its final investigative reports to the Company's Board and Senior Management .
The facts and conclusions set forth in such reports addressed the following principal areas : (i)
Defendant J . Kim's diversion of the Company's revenues and assets attributable to the diverted
revenues ; (ii) expenses incurred by the Company for Defendant J . Kim that were not substantially
connected to the Company's activities or business ; (iii) the possible misapplication of certain
revenue recognition policies ; and (iv) potential tax consequences to the Company as a result of the
investigative findings . Based on the results of the Audit Committee's investigation, the Board
resolved that : (i) the Company will restate its financial statements ; (ii) the Company will undertake
certain remedial measures to improve its internal controls over financial reporting ; and (iii) criminal
and civil actions are to be brought against Defendant J . Kim .
115 . On May 12, 2006, Gravity filed the Amended 2004 20-F which included its restated
financial statements for the years ended December 31, 2002, 2003 and 2004 .
Additional Scienter Allegation s
116 . As alleged herein, Defendants acted with scienter in that Defendants knew that the
public documents and statements issued or disseminated in the name of the Company were
materially false and misleading; knew that such statements or documents would be issued or
disseminated to the investing public ; and knowingly and substantially participated or acquiesced in
the issuance or dissemination of such statements or documents as primary violations of the federal
securities laws . As set forth elsewhere herein in detail, Defendants, by virtue of their receipt of
-48-
information reflecting the true facts regarding Gravity, their control over, and/or receipt and/o r
modification of Gravity's allegedly materially misleading misstatements and/or their associations
with the Company which made them privy to confidential proprietary information concernin g
Gravity, participated in the fraudulent scheme alleged herein .
117 . While Gravity insiders were issuing false and misleading statements about Gravity
and its business , the Company completed its IPO of at least 8 million ADSs realizing approximately
$70 million in net proceeds . In addition, Defendant J . Kim sold his entire majority interest in th e
Company during the Class Period .
118 . As a result of its improper accounting practices , Gravity has restated its financial
statements from 2002 through 2004 .10 In so doing, Gravity has made the determination that such
financial statements were materially misstated because, as noted above, only materially misstate d
financial statements need be retroactively restated . For example, Gravity has now determined its ne t
income for the year ended December 31, 2003, as reported in its IPO prospectus was misstated b y
more than 30% . Indeed, Defendants knew, or recklessly ignored, that the financial results Gravit y
issued after its IPO were materially false and misleading . Evidencing Defendants' intent to misstat e
the Company's financial reporting during the Class Period, Gravity has now announced that :
it has restated or will restate its every financial statement it has made public to
investors ;
every financial statement that the Company has publicly issued to investors which
has not been restated should not be relied upon ;
• its former founder and Board Chairman "diverted" funds from the Company during
the Class Period ;
10 Gravity has yet to release its restated financial statements for the quarters ended March 31, 2005
and June 30, 2005 .
-49-
• it has now filed criminal charges against its former founder and Board Chairman
with the Seoul Central District Prosecutor's Office ;
• it "intentionally" engaged in premature revenue recognition practices during the
Class Period;
• numerous executive officers and directors have "resigned ;" and
• it admitted to the existence of numerous material deficiencies in its internal controls
over financial reporting.
119 . The magnitude and duration of Gravity's improper accounting coupled with the abov e
admissions, actions, resignations, and internal control deficiencies are not indicative of innocen t
record keeping mistakes. Rather, they are associated with fraudulent finan cial reporting .
120 . As noted in the SEC's Staff Accounting Bulletin No . 99 :
For the reasons noted above, the staff believes that a registrant and the
auditors of its financial statements should not assume that even small intentional
misstatements in financial statements, for example those pursuant to actions to
"manage" earnings, are immaterial . While the intent of management does not render
a misstatement material, it may provide significant evidence of materiality . The
evidence may be particularly compelling where management has intentionally
misstated items in the financial statements to "manage" reported earnings . In that
instance, it presumably has done so believing that the resulting amounts and trends
would be significant to users of the registrant's financial statements . The staff
believes that investors generally would regard as significant a management practice
to over- or under-state earnings up to an amount just short of a percentage threshold
in order to "manage" earnings. Investors presumably also would regard as
significant an accounting practice that, in essence, rendered all earnings figures
subject to a management-directed margin of misstatement . [Footnotes deleted.]
[Emphasis added .]
Applicability of Presumption of Reliance :
Fraud on the Market Doctrine
121 . At all relevant times, the market for Gravity ADSs was an efficient market for the
following reasons, among others :
(a) Gravity ADSs met the requirements for listing, and was listed and actively
traded on the NASDAQ, a highly efficient and automated market ;
-50-
(b) as a regulated issuer, Gravity filed periodic public reports with the SEC and
the NASDAQ ;
(c) Gravity regularly communicated with public investors via established marke t
communication mechanisms, including through regular disseminations of press releases on th e
national circuits of maj or newswire services and through other wide-ranging public disclosures, suc h
as communications with the financial press and other similar reporting services; and
(d) Gravity was followed by several securities analysts employed by majo r
brokerage firms who wrote reports which were distributed to the sales force and certain customers o f
their respective brokerage firms . Each of these reports was publicly available and entered the publi c
marketplace .
122. As a result of the foregoing , the market for Gravity ADSs promptly digested curren t
information regarding Gravity from all publicly available sources and reflected such information i n
Gravity's stock price. Under these circumstances , all purchasers of Gravity ADSs during the Clas s
Period suffered similar injury through their purchase of Gravity ADSs at artificially inflated price s
and a presumption of reliance applies .
Transaction and Loss Causatio n
123 . The materi al misrepresentations and omissions pa rticularized in this Complaint
directly or proximately caused or were a substantial contributing cause of the damages sustained b y
Plaintiff and other members of the Class .
124. As described herein, during the Class Period, Defendants engaged in the fraudulent
scheme, and made or caused to be made a series of materially false or misleading statements abou t
Gravity and its products .
125 . The scheme, including the material misstatements and omissions, had the cause an d
effect of creating in the market an unrealistically positive assessment of Gravity and its products ,
-51-
thus causing Gravity ADSs to be overvalued and artificially inflated during the Class Period .
Defendants' scheme, including the materially false and misleading statements during the Clas s
Period, resulted in Plaintiff purchasing the Company's ADSs at artificially inflated prices .
126 . Defendants' improper conduct caused the damages complained of herein . When the
material misstatements and omissions in the Prospectus became known to investors on May 12 ,
2005, the price of Gravity's ADSs plunged more than 70% from the Class Period high IPO price o f
$13 .50 . Several months later, on or about August 30, 2005, the price of Gravity's ADS nearl y
doubled to $12 .14 per ADS when the Company announced that Defendant J . Kim sold his entire
interest in Gravity to EZER . Ultimately, at the end of the Class Period on November 10, 2005, whe n
Gravity announced the Restatement, the price of Gravity ADSs closed at $6 .44 per ADS .
127 . As a result of these revelations , and the corresponding drop in the price of Gravity' s
ADS, Plaintiff and Class members suffered real economic loss .
128 . Further, the timing and magnitude of Gravity ADSs p rice declines negate any
inference that the loss suffered by Plaintiff was caused by changed market conditions ,
microeconomic or industry factors or Company-specific facts unrelated to Defendants ' fraudulent
conduct . The economic loss, i. e., damages, suffered by Plaintiff and other members of the Class was
a direct result of Defendants' fraudulent scheme to artificially inflate the price of Gravity and th e
subsequent significant decline in the value of Gravity ADSs when the true state of the Company' s
operations and finances were revealed to the market and investors .
No Safe Harbo r
129 . The statutory safe harbor provided for forward-looking statements under certai n
circumstances does not apply to any of the allegedly false statements pleaded in this complaint .
Many of the specific statements pleaded herein were not identified as "forward-looking statements "
when made . To the extent there were any forward-looking statements, there were no meaningful
-52-
cautionary statements identifying important factors that could cause actual results to differ materiall y
from those in the purportedly forward- looking statements . Alternatively, to the extent that the
statutory safe harbor does apply to any forward-looking statements pleaded herein, Defendants ar e
liable for those false forward-looking statements because, at the time each of those forward-lookin g
statements was made, the particular speaker knew that the particular forward-looking statement wa s
false, and/or the forward-looking statement was authorized and/or approved by an executive office r
of Gravity who knew that those statements were false when made .
130 . By virtue of the foregoing, Defendants have violated Section 10(b) of the Exchang e
Act, and Rule 1Ob-5 promulgated thereunder . As a direct and proximate result of Defendants '
wrongful conduct, Plaintiff and the other members of the Class suffered damages in connection with
their respective purchases and sales of the Company's securities during the Class Period .
COUNT IV
Against Gravity and Defendants R . Kim, Seo, J . Kim And Moon
for Violation of Section 10(b) o f
the Exchange Act and Rule 10b-5 Promulgated Thereunde r
131 . Plaintiff incorporates ¶¶1-130 by reference herein . In this Count, the term
"Defendants " refers only to Defendants Gravity, R . Kim, Seo, J . Kim and Moon.
132 . During the Class Period, Defendants disseminated or approved the false statement s
specified above, which they knew or deliberately disregarded were misleading in that they contained
misrepresentations and failed to disclose material facts necessary in order to make the statement s
made, in light of the circumstances under which they were made, not misleading .
133 . Defendants violated Section 10(b) of the Exchange Act and Rule l Ob-5 in that they :
(a) Employed devices, schemes, and artifices to defraud ;
-53-
(b) Made untrue statements of material facts or omitted to state material fact s
necessary in order to make the statements made, in light of the circumstances under which they wer e
made, not misleading ; or
(c) Engaged in acts, practices, and a course of business that operated as a fraud o r
deceit upon plaintiff and others similarly situated in connection with their purchases of Gravity AD S
during the Class Period.
134. Plaintiff and the Class have suffered damages in that, in reliance on the integrity o f
the market, they paid artificially inflated prices for Gravity ADSs . Plaintiff and the Class would no t
have purchased Gravity ADSs at the prices they paid, or at all, if they had been aware that the marke t
prices had been artificially and falsely inflated by Defendants' misleading statements .
135 . As a direct and proximate result of these Defendants ' wrongful conduct, Plaintiffs and
the other members of the Class suffered damages in connection with their purchases of Gravity AD S
during the Class Period.
COUNT V
Violation of Section 20(a) of the Exchange Act
Against Defendants R. Kim, Seo, J . Kim and Moon
136 . Plaintiff incorporates TT1-135 by reference herein . In this Count, the term
"Defendants" refers only to Defendants R . Kim, Seo, J . Kim and Moon.
137 . Defendants R . Kim, Seo, J. Kim and Moon acted as controlling persons of Gravit y
within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their highlevel positions, and their ownership and contractual rights, participation in and/or awareness of the
Company's operations and/or intimate knowledge of the false financial statements filed by the
Company with the SEC and disseminated to the investing public, Defendants R . Kim, Seo, J . Kim
and Moon had the power to influence and control and did influence and control, directly or
-54-
indirectly, the decision-making of the Company, including the content and dissemination of th e
various statements which Plaintiff contends are false and misleading . Defendants R . Kim, Seo, J .
Kim and Moon were provided with, or had unlimited access to, copies of the Company's reports ,
press releases, public filings and other statements alleged by Plaintiff to be misleading prior t o
and/or shortly after these statements were issued and had the ability to prevent the issuance of th e
statements or cause the statements to be corrected .
138.
In particular, each of these Defendants had direct and supervisory involvement in th e
day-to-day operations of the Company and, therefore, is presumed to have had the power to contro l
or influence the particular transactions giving rise to the securities violations as alleged herein, an d
exercised the same .
139. As set forth above, Defendants each violated Section 10(b) and Rule I Ob-5 by their
acts and omissions as alleged in this Complaint . By virtue of their positions as controlling persons ,
Defendants R . Kim, Seo, J . Kim and Moon are liable pursuant to Section 20(a) of the Exchange Act .
As a direct and proximate result of Defendants' wrongful conduct, Plaintiff and other members o f
the Class suffered damages in connection with their purchases of the Company ADSs during th e
Class Period.
PRAYER FOR RELIEF
WHEREFORE, Plaintiff, on behalf of itself and the other members of the Class, pray fo r
judgment as follows :
A . declaring this action to be a class action properly maintained pursuant to Rule 23(a)
and (b)(3) of the Federal Rules of Civil Procedure, certifying the Class and certifying their counse l
as Class Counsel ;
B . awarding Plaintiff damages against all Defendants jointly and severally, together wit h
interest thereon ;
-55-
C. awarding Plaintiff rescission on Count II to the extent they still hold Gravity ADSs ,
or if sold, awarding rescissory damages in accordance with Section 12(a)(2) of the Securities Act ;
D . awarding Plaintiff their costs and expenses of this litigation, including reasonabl e
attorneys' fees, accountants' fees and experts' fees and other costs and disbursements ; and
E . awarding Plaintiff such other and further relief as may be just and proper under th e
circumstances .
JURY TRIAL DEMANDE D
Plaintiff hereby demands a trial by jury.
DATED : July 10, 2006
LERACH COUGHLIN STOIA GELLER
RUDMAN & ROBBINS LL P
SAMUEL H. RUDMAN (SR-7957 )
SAMUEL H . RUDMAN
58 th Se ce Road , Suite 200
Melville , NY 1174 7
Telephone: 631/367-7100
631/367-1173 (fax)
Liaison Counsel for Plaintiffs
PROVOST UMPHREY LAW FIRM, LLP
JOE KENDALL
WILLIE C. BRISCO E
3232 McKinney Avenue, Suite 700
Dallas, Texas 75204
Telephone : 214/744-3000
214/744-3015 (fax )
Lead Counsel for Plaintiffs
-56-
STEWART, ROELANDT, STOESS,
CRAIGMYLE & EMERY PLL C
JOHN FRITH STEWART, ESQ .
6506 West Highway 2 2
P .O. Box 307
Crestwood, KY 40014
Telephone : 502/241-4660
502/241-9301 (fax )
Additional Counselfor Plaintiffs
-57-
CERTIFICATE OF SERVIC E
I hereby certify that on July 10, 2006, a copy of the foregoing Consolidated Class Actio n
Complaint was sent, via U .S . Mail , postage prepaid to the following parties listed below :
Joseph P . Moore
Eliza M . Sporn
Debevoise & Plimpton LLP
919 Third Avenu e
New York, NY 10022
Tel: 212/909-6241
Fax : 212/521-7241
Attorneys for Defendants
Joe Kendall
Willie Brisco e
Provost & Umphrey Law Firm, LLP
3232 McKinney Avenue , Suite 700
Dallas, TX 7520 4
Tel: 214/744-3000
Fax: 214/744-301 5
Lead Counsel for Plaintiffs
Anne Martin
Paralegal